Taught By

Dr. Peter Navarro

Professor

Transcript

[MUSIC] While the Classical Economists made a powerful theoretical argument, as to why a recessionary economy should always adjust back to full employment. The reality of the Great Depression in the 1930's resulted in a search by the world's political leaders for an alternative economic solution. That solution turned out the be Kenynesian economics. To John Maynard Keynes, the problem with classical economics was not the price adjustment mechanism that it relied on per say. Rather Keynes believed that before such a mechanism had time to work, it would be dwarfed by a much more powerful and deadly income adjustment mechanism. To Keynes, when an economy sinks into recession, peoples' incomes fall. This fall in income causes them to both spend less and save less, while businesses respond by investing and producing less. This reduction in consumption, savings, investment and output in turn drives the economy deeper into recession rather than back to full employment. While eventually income will fall far enough so that savings and investment return to equilibrium. The economy will be at a level well below full employment with no way to get out stuck in a rut with a glut of goods. Just as Thomas Malthus predicted in his original critique of the Classical model. Out of this classical Keynes debate have emerged two important models that are frequently used in macro economic analysis. One model, the aggregate supply aggregate demand framework, has its roots in classical economics. It allows for price adjustments in it's framework. The second model, the Keynesian model, assumes that prices are fixed. In the reminder of this lecture, we will develop the aggregate supply, aggregate demand model and then turn to the Keynesian model in the next lecture. As we shall see both models are very helpful in understanding how modern economies function

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